Hatching Business Success

The general rule of thumb is that most new businesses fail. But the incubator model is beginning to change those statistics for companies who seek the right kind of help.

In 2005, CAP Technologies, Denham Springs, La., developed a technology to take mill scale off steel and pacify the metal while applying a coating. In 2012, the company owns an $8 million facility and has more than 25 employees. It recently signed a major $4 million contract with a Fortune 100 company, and has signed licensing agreements with two major metals companies, Nucor and Tata Steel.

Funding Sources:
Service contracts; Rental income and service charges; Funding from private sector organizations; Funding from universities, independent R&D groups; Income from events and programming

Reel Solar, a San Jose, Calif.-based developer of thin-film photovoltaic technology recently secured $15 million in investments from X/Seed Capital, and moved from a 6,000-square-foot laboratory to a 58,000-square-foot research and development facility in a northern part of the city, despite still being in stealth mode.

Founded in San Francisco in 2005, Fluxion Biosciences manufactures analytical instruments for functional cell-based assays and has won two R&D 100 Awards in the last three years.

What do these companies have in common? They got their start in incubators.

A new strategy for starting a business
Perhaps the most famous metric of entrepreneurship is the business survival rate. Figures like eight of 10 startups don't last the first year are widely cited and certainly have shock value.

The real data is less scary, but still discouraging. The U.S. Department of Commerce and the Census Bureau, basing their results on the 2000 census, show that seven out of 10 new employer firms in the United States survive at least two years. However, only 48.8% of new companies started before 2000 made it to the fifth year. And that number gets worse with time.

That's in stark contrast to figures cited by the National Business Incubation Association (NBIA), Athens, Ohio. According to Tracy Kitts, vice president and chief operating officer, 87% of businesses that were nurtured in a business incubator make it through five years of business on their own. The same study, dating from 2006, claims the survival rate for companies that do it alone without the benefits of incubator support is 44%.

As a result, incubators are everywhere. In 1980, 12 incubators operated in the United States. In 2006, the last time a comprehensive survey was made by NBIA, more than 1,400 incubators operated in North America, and more than 1,100 operated in the United States alone. Together they contributed $17 billion in economic value. Globally, Kitts estimates the number of incubators in 2012 could number from 7,000 to 8,000.

The numbers are convincing, but individual success stories are showing that, increasingly, companies are leaning on organizations with specific expertise, manufacturing know-how, or high-end scientific instrumentation. An incubator can teach the innovator how to operate a business (often this is new information for an innovator), how to find expert partners, how to line up funding, and how sustain it.

The industry is growing so quickly that keeping track of them all is difficult. He estimates that more than two new incubation programs appear each week; 2,000 incubators are members of NBIA.

"I used to have a software company. If I had access to a business incubation company at the time, things would have been different," says Kitts. An incubator, he continues, makes business formation its business, so to speak, so it has the knowledge to build a business plan, build a marketing plan, find funding—from Small Business Innovation Research (SBIR) grants from the government to angel investments—and protect intellectual property. And chances are, says Kitts, the incubator has already dealt with a similar company.

Incubators have grown so strong that a minor backlash has emerged. Max Levchin, a Silicon Valley fixture who helped start Paypal, told the Wall Street Journal in late 2011 that technology accelerators, a type of incubator that largely serves to channel capital to new companies, have grown too numerous and have created a glut of small companies with products too similar to compete effectively. More than 100 of them exist in San Francisco alone, up from just four in 2007. But many of these efforts, focused as they are on specific fast-growth technologies such as mobile software, are on the fringe of mainstream business development.

"In 2000, a lot of people calling themselves incubation programs weren't incubation programs," says Kitts. The dot-com boom gave these incubators—namely venture capital—a bad name. "People have gotten smarter about how you start a business. Information is anywhere, but a well-run incubation program can guide a client through the entire process."

Incubators provide a network of support, contact with other entrepreneurs, proper legal and accounting advice, and the physical space needed to do actual development. Kitts cites a telling statistic: 84% of companies that graduate from an incubator stay in the communities where they were incubated. This is significant, says Kitts, because most business incubators are supported by local economic development groups. Fewer than 10% of these incubators are for-profit organizations, and those tend to be run by investor groups that take an equity stake in the companies they're sponsoring.

"Incubators offer a tremendous return on investment in public and private dollars," says Kitts, who cites figures that show for every $1 invested in a new company through public or private funding organized through incubators, $30 of return is seen in local tax revenues alone.

A typical incubator is funded through a 50-50 split of service rental fees and economic development dollars from state and federal sources. The vast majority of incubators are mixed use.

"They might deal in IT by design, but they are usually looking to work with a lot of different companies," says Kitts.

Incubators move into the mainstream
Some of the most successful incubator models have been established at universities. For decades, as their attendances and endowments have grown, universities have sought to increase their value by not just conducting high-level research, but commercializing it as well.

Houston Technology Center

Incubator Name:
Houston Technology Center

click to enlarge

Houston Technology Center

Location:
Houston

Year Established:
1999

Incubator Type:
Business accelerator and technology business incubator

Missions:
Generate successful startups; Commercialize technology developed at universities and R&D centers; Spur economic development and/or job creation in a given region; Strengthen development of a particular type or sector of technology

The San Jose BioCenter in California is a specialized incubator that fuels companies involved in life science, biotech, and clean technologies. The BioCenter's mission is to provide emerging companies with the advantages enjoyed by larger companies through access to a new generation of specialized facilities; capital equipment; world-class laboratory services; and commercialization support, contacts, and expertise. Established in 2004 by San Jose State University as part of an effort to revitalize an industrial part of San Jose, the center is equipped with common laboratory areas including a cold room, tissue culture rooms, service alcoves, equipment rooms, a biology laboratory, and chemistry analytics. Client companies occupy individual wet/dry laboratories and office space.

"During the past seven years, the BioCenter's clients have had success in securing growth capital, which can mean grants, angel financing, growth financing, development dollars, licensing fees, royalties, etc.," says Steven Brewster, vice president, marketing and public relations at PreScience International Inc., a San Francisco-based firm that manages a number of incubator- and innovation-related centers in California, such as the Berkeley BioExec Institute and Janssen Labs in San Diego.

A major component of San Jose's life science initiative, the BioCenter was a project of the San Jose Redevelopment Agency, and is an operating project of the San Jose State University Research Foundation. This is a common model for funding and managing an incubator because the foundation can serve as a resource for fiscal and risk management services to the incubator. As such, it is closely entwined in the economic health of the community. According to Brewster, it has been instrumental in starting a life science industry cluster in Edenvale, a community in the southern end of San Jose.

"When the BioCenter opened, clients were exclusively in life science. Since wet lab space is needed for the development of other innovations, growth has been seen in sectors needing this type of offering," says Brewster.

The GENESIS Technology Incubator, Little Rock, Ark., is also typical of today's university-based centers. Though its affiliation with the University of Arkansas is strong, and it relies on the expertise and facilities owned by the university, it operates much as its own entity, with its own staff, services for hire, and budget. Like most incubators, GENESIS actively seeks new clients, screens them to determine their qualifications, and provides business training and assorted funding location services. Its efforts have allowed the incubator to grow from 11 client companies in 2004 to 20 companies in 2011. Two former affiliates of GENESIS have been recipients of a Frost & Sullivan Award for Excellence in Technology and another existing client has been awarded the Tibbetts Award for most innovative small business.

Physical space is a common offering at incubators, because it is usually what a startup company needs first. Some incubators provide the raw materials for research, but many do not.

"We limit each company to two laboratories and provide shared equipment services. However, we do not provide specialty equipment such as microscopes," says Kevin O’Sullivan, president of Massachusetts Biomedical Initiatives (MBI) in Worcester.

A private, independent economic development organization, MBI differs from its university-affiliated cousins in that it was formed independently of academic leadership and instead was born of venture capital, having invested more than $8 million of public funding and more than $50 million in private money to create three major incubator centers, more than 2,000 jobs, and $600 million in additional funding.

MBI has produced a number of successful companies, including T-Breeders/VivaCell, which was sold to PerkinElmer, and Blue Sky Biotech, a protein synthesis contract research company later sold to Ampersand Ventures.

Services tend to be similar across the spectrum of incubators. Louisiana Business & Technology Center (LBTC) and Louisiana State University Innovation Park in Baton Rouge, are typical of most incubators in its breadth of services and handling of clients. When LBTC finds a client, or a client finds them, the staff first interviews and screens the applicants, checking their references. If satisfied with the clients' suitability and compatibility with the incubators, LBTC analyzes their needs and admits them if a benefit is apparent. A leasing agreement is arranged if physical space is involved, and the final step is to begin the business planning, mentoring, and coaching.

Some incubators have an even more specific set of criteria for a startup. Houston Technology Center (HTC), for example, focuses on five fast-growth technology segments: energy, information technology, life sciences, nanotechnology, and NASA/aerospace.

In addition, says Maggie Joplin, director, marketing and communications at HTC, the ideal client will be headquartered in the Gulf Coast area; have proprietary, disruptive technology; have potential to reach $30 million in funding by the fifth year; and be willing to assemble the appropriate management team.

Half-business, half-school
Incubators are often compared to academic institutions. Clients are "students" and must perform well over a period of time—as long as four years. Assessments are conducted on a quarterly basis, and when all established incubation benchmarks are reached, the client "graduates".

Active pursuit of clientele is also common among incubators. Over the past year, the San Jose BioCenter developed a new offering, the BioCenter Concept Lab. For as little as $500 per month, entrepreneurs can now work on their proof-of-concept within the Concept Lab. The BioCenter Concept Lab will be equipped with a fume hood, bench space, centralized water and gas supply, storage, emergency power, emergency shower/eyewash, and high-speed Internet. The companies within the BioCenter Concept Lab will also get access to more than $5 million worth of common equipment in the core research areas, according to Brewster.

LBTC also seeks clients, but because of its connections with attorneys, bankers, accountants, and staff at the state's chamber of commerce and state's department of economic development, says Executive Director Charles F. D'Agostino, good prospects are plentiful.

Despite the similar roles filled by incubators with regard to services, pricing structures for clients can vary widely depending on the type of physical space they have.

"Even though LBTC charges higher-than-market rates for its physical space, the packaged services make them highly competitive," says D'Agostino.

At the Coachella Valley iHub, Palm Springs, Calif., a private business incubator specializing in sustainable technologies, rent is initially free with potential for gradual rent structure at or below market rate and membership fees ranging from $250 to $500.

The incubator is still in the early stages of its program with only four physical tenants as of January 2012. However, assistant director Kyle Wagner reports that one client is ready to move into industrial space to start manufacturing their product, which converts gas-powered cars to run electric.

At the San Jose BioCenter, pricing is based on a value-added package that includes laboratory space, business and operations support services, common laboratory equipment usage, networking and partnering events, and mentoring. MBI charges a gross, all-inclusive monthly/yearly fee requiring a one-year lease term.

HTC's Client Acceleration Program is an extensive two-year program in which the acceleration directors work directly with the management teams of client companies. Upon signing a client agreement, the client donates a 1% warrant. MBI has adopted a similar pricing scheme.

The QB3 Garage/Innovation Network in San Francisco is, financially, a landlord. Tenants pay university facilities independently for use of equipment. QB3 also differs from other incubators in that it relies on clients to find them.

"Tenants are vetted by a committee at our institute. We generally do not discriminate based on technology, although we try to avoid hosting competing companies. It is key for us to assess the personalities of the entrepreneurs to ensure there is no conflict with existing tenants. We have a 'no-bozo' rule," says QB3 communications director Kaspar Mossman, PhD.

QB3's best locations, typically on the campus of San Francisco State University, are constrained in size by state regulations. It also doesn't provide scientific apparatus in the incubators. Companies have to buy their own instruments and equipment, and often end up sharing with each other, according to Mossman.

"We mentor many tenants and provide concierge service in the form of introductions to technical people, VCs, bankers, etc. On rare occasions our venture fund invests, but giving up equity is not a routine requirement," says Mossman at QB3.

Not all payments are upfront, however. Many accelerators and some incubators enter into equity or profit-sharing agreements. When a technology emerges from a university, in particular, the new ventures often pay royalties to the originator. Mezzo Technologies (Baton Rouge), which has commercialized heat exchange technologies, graduated from LBTC in 2005, subsequently winning more than 14 SBIR grants from NASA and the U.S. Department of Defense. In part because it was founded by a Louisiana State University (LSU) mechanical engineering faculty member, it pays royalties to the university.

As resident companies grow and scale, they tend to outgrow their spaces. Sometimes the companies must immediately sever their ties with the incubator and move on. Other times, the incubator grows to accommodate large companies or, as in the case of the Advanced Technology Development Center at Georgia Institute of Technology, they build an entirely new incubator devoted to a particularly strong technology area, such as bioscience. Even a large university incubator like the San Jose BioCenter finds this to be a common occurrence. Tandem Diagnostics, now Aria Diagnostics, joined the BioCenter in early 2010 after receiving $12.5 million from Venrock, one of the oldest venture capital firms in the world. Tandem, developing a proprietary prenatal diagnostic, initially joined the BioCenter with only five employees, says Brewster. From 2010 to 2011, they grew to over 30 employees and will expand to 60 employees by early 2012. Through their growth, they secured additional laboratory and office space, growing to approximately 5,000 square feet within the BioCenter. This exponential growth resulted in Tandem collaborating with Mission West Properties to move into a much larger, 30,000-square-foot space.

Part of the attraction of incubators for client companies is the investment that they have in the clients' success. At QB3, the companies currently in their network employ more than 200 people and have raised more than $220 million in funding. Taken together, says Mossman, they would rank as the fifth-largest biotech company in San Francisco. QB3 successes in San Francisco include Fluxion Biosciences; True Materials, which was acquired for $25 million; and Siluria, which received $13 million in first-round funding.

HTC points to LaserGen Inc., a Houston-based biotechnology company commercializing next-generation DNA sequencing chemistry. The company has recently received $5 million in R&D funding through grants and strategic partners. Similarly, Stematix Inc. specializes in stem cells and is growing quickly.

The San Jose BioCenter cites a number of examples, including Aridis Pharmaceuticals, an early client that secured a total of over $14 million in grant funding. Over the past year, they expanded within the BioCenter to occupy a third laboratory. Other successes include Reviva, an emerging pharmaceutical company that has entered a Phase I clinical study with its novel molecule for schizophrenia and schizoaffective disorders. In addition, another client, Single Cell Technology, has developed a unique platform to identify and optimize antibodies for both therapeutics and diagnostics. Recently, the company secured a proof-of-concept contract with a large biopharmaceutical company.

Big-name R&D meets open innovationBattelle Memorial Institute, Columbus, Ohio, the world's largest independent R&D organization, has worked closely with numerous incubators over the years. Battelle's experience with technology commercialization more typically extends to federally funded laboratories, and it operates several U.S. Department of Energy laboratories, notably Oak Ridge National Laboratory.

Battelle itself is so large, however, that its involvement with incubators is inevitable.

"We don't run incubators, but we do work around the country helping others in the formation of incubators," says Mitch Horowitz, vice president and managing director of Battelle's Technology Partnership Practice (TPP), Cleveland. TPP helps regions and states re-position their technology companies and assets to become more competitive. Led by experts in developing private-public partnerships, TPP has played a major role in establishing programs for technology-led economic development at dozens of universities and public research parks. These projects include developing a roadmap for the polymer and advanced materials industry in northeast Ohio at the behest of an organization of industrial and academic leadership, and forming strategies for biotechnology development in a number of states. Horowitz himself has been involved in establishing biotechnology incubators in Maryland, becoming a technology advisor to the state's Secretary of Economic and Employment Development.

"Most incubators were originally public incubators. Many are associated with academic institutions or research parks," says Horowitz. In 2007, Battelle and the Association of University Research Parks, Tucson, Ariz., conducted a survey on the state of research parks in the United States and found that the typical research park has devoted at least 10% of its facilities to incubators. Many large corporations have started incubator-type resources to attract and diversify their technology base.

Xerox's Palo Alto Research Center (PARC) in California is unusual in that it has transformed from a corporate blue-sky R&D laboratory along the lines of Bell Labs into an increasingly recognized for-profit open innovation center. According to Lawrence Lee, senior director of strategy at PARC, the center needed to adapt to become more valuable, both to its parent company and to the process of innovation in general. The company intensified its effort to spin-out new companies, and adopted entrepreneur-in-residence models.

"We're not a true product company in the sense that we're taking products directly to commercial spaces. We are more involved with early-stage R&D," says Lee.

Unlike incubators, PARC isn't there to hold a new company's hand as it learns how to navigate the business world for the first time. Nor does it charge for services in the way that incubators do. However, PARC can help a company, especially newer ones, look at technology and understand how much more investment is required before it can reach market.

According to Lee, there are two sides to the value proposition at PARC. First, the center invests its own resources in developing new technologies, as well as helping to seed government technology. Second, PARC can identify partners and clients to develop those technologies. PARC can also perform that other crucial service an incubator can provide: market assessment. All new businesses must find the level of risk they are willing to create.

"It's very difficult now with startups to find the right spot on the value/risk curve. As you reduce risk, you increase value. But it's not smooth, it's a step function. The question for companies is 'where are the deflection points?'"

Although occasionally PARC does incubate, its more scalable aspect is a different set of scarce resources. This includes access to advanced machinery such as high-end lasers, chemical vapor deposition process machinery, and six-axis computer-controlled cutting machines. In PARC's work with HexaTech, Morrisville, N.C., a bulk substrates supplier aiming to produce light-emitting diodes (LEDs) that function in ultraviolet wavelengths, they provided access to a commercial LED reactor that cost $1 million. PARC has already conducted research on UVLEDs, so it had the expertise. Reactor machinery was too far out of reach for Hexa-Tech to purchase, but it was crucial, according to Lee, to testing the materials they had assembled.

Incubators go global
The incubator is far from a U.S.-only phenomenon. In addition to NBIA's international presence, other incubation organizations have appeared, including the Asian Association of Business Incubators, the European Business Network, and IndroTech in Brazil. The International Association of Science Parks, headquartered in a major research park in Malaga, Spain, is closely tied to the business of incubators by virtue of the fact that 90% of the nearly 350 research parks in its membership operates an incubator of their own.

According to Luis Sanz, director general of IASP, research parks and incubators often share the same management team, but even if they are separate organizations they work closely together by necessity.

IASP extends association benefits to the incubators in their member parks and sometimes it forms direct alliances with the incubators, and, as in the U.S., the main mission of many science parks is to create and grow new knowledge and technology-based firms. Incubation is part of this.

Louisiana Business & Technology Center and Louisiana State University Innovation Park

Incubator Name:
Louisiana Business & Technology Center and Louisiana State University Innovation Park

Location:
Baton Rouge

click to enlarge

Louisiana Business & Technology Center and Louisiana State University Innovation Park

"In some regions, business incubators have been the seeds of parks that have been created at a later stage," says Sanz. "I would say that there is a common base for incubation throughout the world in the sense that the techniques and methodology to stimulate the creation of new businesses and to mentor entrepreneurs are alike over the globe."
Foreign companies have long recognized the value of the incubation model in the U.S.

Oxford BioTherapeutics, a U.K.-based company, maintains laboratory space at San Jose BioCenter. In January 2011, it announced a strategic alliance with Sanofi-Aventis to license an antibody to develop, manufacture, and commercialize antibody drug conjugate products for the treatment of cancer.

At San Francsco's QB3, for example, two international startups, Pathway Therapeutics of New Zealand and Unhwa Biotech Corp. of South Korea have set up shop, hoping to use shared laboratories and services and proximity to other biotechs and venture capital firms to gain a foothold in the U.S. Pathway recently started preclinical development of a potential once-a-day oral drug to fight a wide range of cancers. It works both ways, too. QB3 incubator tenant Green Pacific Biologicals Inc., a developer of algae fuel technology, has a branch office in Santiago, Chile.

Despite this type of overlap, say Sanz, there are significant cultural differences that must be taken in account. The role of the entrepreneur and businessman is perceived differently in a number of European societies, for example, and its importance is unwritten yet powerful in its effect. Moreover, the IASP team must also take into account national differences in law and regulations that pertain to company creation intellectual property, and even private property.

"With regards to making predictions related to business incubators reacting to increasing globalization I think that we will soon witness some form of 'Darwinian' natural selection, and that only those incubators that understand that today's businesses will be international or will not be are the ones that will continue growing and being operational," says Sanz.

Incubators of the future
The world of incubators has never been static, and from what Horowitz has seen at TPP, he believes it's still speeding up. Part of the evolution, he says, is an effort to keep pace with "business speed", as he calls it.

Horowitz cites the Technology Commercialization Office at the University of Utah, which is taking a new approach to granting access to its facilities with the launch of the Virtual Technology Incubator (VTI). For fledgling companies that take part, the university acts as a "virtual incubator" until they can finance their own laboratories. With the return of funds from its commercialization efforts, the university helps the survival rate of its spin-offs.

The VTI efforts also speeds up the process of creating successful commercial enterprises by offering a Virtual Incubator Projects to its clients. These research vouchers entitle the spin-off up to $50,000 credit for sponsored research conducted at the university. The vouchers will grant the spin-off an option to license any new intellectual property created in the performance of the contract but allow the university's foundation to receive, in exchange, equity from the spin-off equaling 2% of the spin-off company.

NBIA traditionally has defined virtual incubation as the delivery of incubation services solely through electronic means. However, the term may be used interchangeably with "affiliate program" for services delivered to clients that are not in residence in an incubator. "Virtual incubation" also may be used to denote a program that offers services to clients who are located far away from an incubator, when the program does not offer any multi-tenant space.

Incubators have played a major part in a number of urban industrial renewal efforts. In many cities, such as Boston or Atlanta, city governments have promoted the developments of urban business parks and incubators have come in along with them. In San Jose, Brewster says, the city's goal was to build up the life science industry in a sector of the city that really didn't have industry at all. The goal was to redevelop the industrial base and bring jobs nearer to where the population is.

"I think the reason that shift occurred is that urban areas are geared toward talent. That's where the talent is. It's in the cores, not in the exurban environment," says Brewster. "Unless it's part of a larger institution like a university, it's geographically challenging."

The ability for incubators to respond quickly to changing market trends or economic shifts highlights their place in the business landscape. Large corporations rarely have the same mobility, even as they move beyond the spin-out model to an open innovation framework.

So incubators have carved out their place. But how long will the heady growth continue? Will it become the dominant, indispensable model for business genesis, or will it transform into something different?

"Incubators are a very important part of the ecosystem, but they are not by themselves the only part of the solution to technology development," says Horowitz. "There needs to be broader interventions and more attention around the process of technology commercialization and entrepreneurial development. That's the important component. It's not the facility, it's the process."

Lee's experience at PARC has also informed him of the need for a varied approach to successful product development. Universities and corporate R&D centers, he says, will continue to be involved in high-level innovation, especially when tackling difficult problems. Natural language processing is one example Lee cites as evidence of the power of having many contributors. Despite Apple's position as the penultimate marketer of the technology, Siri began in the 1970s at Stanford Research Institute and passed through half-a-dozen top-shelf research universities and several software firms before emerging as a viable product.

"You still need institutions like universities and corporate R&D centers," says Lee, to help develop some of these complex new technologies. PARC itself contributed to natural language technologies which have been licensed to Powerset, a San Francisco, Calif., firm owned by Microsoft that may produce one of the first true natural language Internet search engines.

But the incubator process is nevertheless attractive to companies who recognize that they have proven their value by elevating the success rate for new businesses. The vetting process performed by incubators is quantifiable and repeatable and incubators offer brand credibility as well.

"It's a synergistic effect. That's the biggest reason companies with incubators are so successful. The biggest thing for me is that you can walk into an incubator and ask a question and you are going to get an answer," says Kitts.